Monday, October 17, 2016

Chapter starts with crisis caused by archduke’s
assassination in 1907. The focus was on the role that Benjamin Strong (41 years
old president of bankers trust company.). First sign of financial crisis hit
New York in July 28 when Austria declared war on Serbia.Two days later Russian general mobilization
while stocks experienced largest down by 7 percent on the same day. Major
concern was that the European loans to Americans which amounted to $500
million, EU investors would demand immediate repayment under war conditions. on
the same week major banking officials were summoned in offices of J.P. Morgan
& Co., when London exchange been forced to stop trading, the bankers in New
York decided to close the NY stock exchange. At that time the US was the only
major economy without a central bank. That was motivated by the idea that
putting power in hands of one institution was undemocratic(un-American) due to
such attitude banking policy suffered. So with no central bank, the financial
community turned to J.Pierpont Morgan. He had so much more experience in
finance than any other. He assigned the best financiers to assist him Davison
and Ben Strong and were able to contain some of the damage. After being hit
with such a crisis the vulnerability of the U.S banking system was clear.The U.S Congress decided to act to study
assigning a central bank, but with efforts of lobbying the idea was turned
down. Until the Glass Plan came to life which modified the idea of a single
concentration of power, to having the Federal Reserve Banks and The federal
Reserve Board were to be appointed by the president. So in October 14, Benjamin
Strong aka “Safe Pair of Hands” was formally elected as the first governor of
the Federal Reserve Bank of New York.

5. L’INSPECTEUR DES FINANCES

This chapter starts off with events(&scandals) occurring
in France in 1914. Le Figaro, a newspaper opposing the finance French minister
Joseph Caillaux, published an affair history of the minster. In response his
second wife has purchased a gun and waited for the editor of Le Figaro Gaston
Calmette and shot him dead instantly. The
incident lead to split in France between supporters of Caillaux and enemies.
Rouvier who was prime minster got exiled for two years and came back as a minister
of finance. France at the time was filled with political corruption and
conflict of interest with government officials and politicians. In 1892 major
company went bankrupt and 800,000 French investors lost $200 million. Rouiver
along with 104 financiers got accused of corruption and was forced to
resign.Moreau admired Rouvier despite
his ethical misdoings, so he worked under him and was very loyal to him. In
1905 Rouvier became prime minster again with Moreau as his right hand. Rouvier
defused the crisis by helping to lead to the Anglo-French entente, but months
later the government was voted out.Moreau was sent to the central bank of Algeria and Tunisia (minor french
insitution). In 1908 he was moved back to his hometown. At that time gold coins
began to disappear from circulation. The French had a strong mistrust of banks,
French peasant was told to keep his gold under the matters. In 1914 july
veridtct of Caillaux's wife(who shot the editor)was found guilty. At the time Parisians struggled
on how to pay for their food because silver or gold were hard to get, almost
everything stopped accepting banknotes. The banque announced it was prepared to
continue paying out gold as it has been the largest gold hoarding entity. In
1914 they had more than $800 million in bullion. That gold was to support the French
government in a national endeavor. When order for general mobilization was
issued, French gold reserves were immobilized. When the war broke and in August
the Germens were as close as 25 miles from Paris, they dropped bombs around
Banque de France but the French had already secretly moved its $800 worth of
gold from Banque by rail and truck to south of France. By September the vaults
of Banque in Paris were empty.

6. Money Generals

As the war broke out, no one know why it happened, army
generals were promising to return home by Christmas. Financial officials
because they thought the war will be short they focused on being in a good
financial shape. Everyone predicted that this war will be short by using
European money and liquidity as a measure. Even in 1916 generals were saying it
will end in 6 months, the truth of the matter is that Britain, France, Russia,
Germany, Austria-Hungry were spending $3 billion each month which accounts to
50% of their collective GDP, it was said no other war in history absorbed so
much wealth. So exhausting their funding approaches, they relied on inflation.
They did that by turning to central banks and telling them to print money that
is not backed by gold. Britain was the most responsible in its financial
policy. For the U.S the war was like a fruit that fell from the sky. The demand
for American materials from Europe was enormous the gold influx of U.S created
expansion of credit and money supply doubled. Strong had two big fears. One was
that at the end of the war, this gold would all pour back to Europe, radically
destabilizing the U.S banking system. The other was that the gold would stay,
potentially causing a shortage of reserves in Europe and threatening even
greater inflation at home. So that Fed should coordinate with central banks of
Europe. So he visited Europe and visited Paris Banque de France, then the bank
of England where he met Norman and became good friends. Then he returned to the
U.S in summer of 2016. At the same year Strong was diagnosed with tuberculosis
which he got from his visit to Europe. He moved to Colorado to contain the
infection but went back to NY to finance for the war when U.S entered it in
1917. The United States spent in total some $ 30 billion on the war, a little
over $ 20 billion on its own actual expenditures and another $ 10 billion in
the form of loans. The Fed was responsible for selling Liberty Bonds, which
brought about $20 billion half of it from NY Fed Reserve. Towards the end of
the war the Fed was a transformed system, unlike other centeral banks it had
had resisted purchasing government bonds directly and only indirectly helped to
fuel the expansion in money supply therefore, Fed secured some credibility.

Question:

What do you think would happen if the U.S economy continued
without a central bank (Federal Reserve Bank) during the first Ground War?

Chapter 1 Recap: The
reading starts off in 1914 in London setting the scene for that time. The gold
standard was in effect at this time and it was considered the “lifeblood” of
the financial system. It was believed that a war would be detrimental to
everyone involved due to the economic chaos it would create. We then get
introduced to Norman Angell who moved to the U.S. out of fear of what Europe’s
future looked like. He then moved back to Europe where he started working for
the Daily Mail. Angell wrote a piece
tilted The Great Illusion which
became very popular. Reginald Brett, one of Angell’s followers, founded the
Committee of Imperial Defense which was designed to give the British Empire
military advice. Lord Esher delivered lectures where he argued that the war is
stupid because it leads to commercial disaster, financial ruin and individual
suffering. The chapter ends by saying that Lord Esher and Angell underestimated
to likelihood of a war amongst European countries breaking out.

Question: There wasn’t
too much going on in this chapter as it was a brief introduction to set the
scene and introduce some characters, but the concept of the gold standard was
referred to in a positive manner. In today’s society, money is backed by
government decree (i.e. nothing) while at this time money was backed directly
by gold. Do you think the modern system we experience is dangerous as it is not
backed by gold, or do you think we have moved on since these times and money
can exist in the long-run without being backed by anything?

Chapter 2 Recap: A new
character named Montagu Norman is introduced. He visits London the day Austria
declares war on Serbia. Neither he nor anyone else knew that the financial
system was about to completely fall apart. It was the middle of summer and
Norman decided to depart from Brown Shipley. Norman had an exotic house that he
took pride in but is described as being fairly modest. Norman did not fit in as
a child and was constantly sick. He joined the militia and volunteered for
active service and was sent to South Africa. Norman said he felt like a new man
while away at war. He was awarded the Distinguished Service Order which became
one of his greatest prides. After coming back home, Norman became one of the
four main partners at Brown Shipley. At one point in time, he was engaged but
the engagement fell apart and left Norman emotionally unwell. He then did some
international traveling and finally came home to find out he had GPI and would
only have a few months left to live. Meanwhile, the war going on in Europe
started to pick up momentum as more countries were getting involved. All of the
tension led to uncertainty in the financial markets – all of the loans that
went through London would freeze up in the event of war and gold shipments
would cease which could cause the gold standard to unravel. The stock exchange
closed for the first time in over a century. People rushed to the bank to
exchange their notes into gold. As gold was fleeing from the banks, they
decided to raise interest rates to 10% to give people an incentive to leave
their deposits with the bank. The bank was closed for a holiday and all the
bankers wanted to “extend” the holiday to let the panic die down. Norman’s
primary concern was the survival of Brown Shipley. All of this chaos was good
for Norman’s health as it kept him distracted from his mental status.

Questions: Do you think
the bankers’ desire to extend the holiday and keep the bank closed would have
been a legitimate method to minimizing the financial chaos, or do you think
this approach would have simply delayed the inevitable?

Do you think the action the banks
took of raising the interest rates to 10% would have been sufficiently effective
to deter individuals from withdrawing their wealth from the bank? Would you
have withdrawn your deposits from the bank?

Chapter 3 Recap: Even
though people had been anticipating a war for quite some time, everyone was
surprised by how quickly it was escalating. The Austrian and German government
leaders took vacations during the initiation of the war. A new character named
Hjalmar Schacht is introduced and he is caught off guard by the crisis. He was
not very high up on the totem pole at the bank he worked at named Dresdner and
couldn’t really do much about the crisis but was surprised it was allowed to
reach the point that it had. Schacht came from a lower-middle-class family but
had a strong work ethic and desire to succeed. Schacht’s father moved to the
U.S. temporarily but ultimately moved back to Germany with horrible timing as
the economic downturn was just beginning. Schacht’s mother came from a family
that was better off than his father, but when she chose to marry Wilhelm
Schacht, she took a step down on the social ladder and inherited nothing. Schacht
was bullied for his family’s poorness so once he finished school and escaped
this misery, he found joy in poetry. After bouncing around from one university
to another, he ultimately became a banker. He married a Prussian woman and they
had two children. He never believed the war would actually happen and he thought
there would be a diplomatic solution, but this was not the case. Germany
declared war on France. As Britain stepped in to defend Belgium, Germany was
now at war with another country. Despite all of this, Germany’s financial
system seemed to be doing better than the rest of Europe’s. This didn’t last
and one day in particular, Germany’s financial situation took a dramatic turn
for the worse. As the bank almost fell below its minimum of gold backing, the
Kaiser was worried of being driven off the gold standard. In August, the bank
finally felt confident they had enough gold backings. As Schacht watched the war
begin to unfold, he had a clear vision of his own future (though at this point
in the novel, we do not know what that vision is).

Questions: As the war
lead to overall uncertainty, if the bank had not held a sufficient amount of
gold like they temporarily feared, do you think this would have had any impact
on the development war itself? What do you suspect would have happened to the
banks if they fell below this minimum holding requirement?

Sunday, October 9, 2016

In 1994, LTCM earned 28 percent
which is a lot due to the fact that the average bond investor had lost
money.J.M. would write a letter to his
investors on the possibility and odds of losses in the future and for investors
to not expect a repeat.Merton and
Scholes used their advanced math knowledge to devise precise mathematical odds
of when and how much they could possibly lose.

LTCM tried to quantify every aspect
of trading, associating past volatility with their assessment of future
risks.They were basically conducting an
experiment in managing risk by numbers.LTCM trades were an attempt at exploiting spreads that reflected what
they seemed to be inaccurate future volatility risk.Black-Scholes made an assumption that the
volatility of a security is constant.Merton took that assumption a step further and assume that prices would
trade without any jumps.Merton found
that a trader who owned both the price of an option and the price of the stock
could operate in a perfect, risk-free arbitrage.This would become an essential building block
in LT’s hedging strategies.

There were multiple people who
either studied under or with Black, Scholes, and Merton that found inaccuracies
in their assumptions, such as Eugene Fama.He discovered that there were many more days of extreme price movements
than would occur in a normal distribution.The tail ends of the distribution differed from that of Merton’s because
due to the fact he thought of them to be swollen.Such an example was Black Monday.

Over the first two years, LTCM had
only one month which they lost more than 1 percent.Their equity capital had almost tripled to a
total of $3.6 billion in that time.

Question:

Why do financial markets run to extremes more
often than say, a coin flip?How would
this impact the market and investors?